Tail wags dog

Last week we looked at the odd situation whereby longevity risk is regulated more strictly in an insurance-company annuity portfolio than in a company pension scheme.  One argument for the different treatment is that the sponsoring employer is a source of ongoing financial support for the scheme.  This is not the case for annuities, where typically a single premium is handed over at outset and there is no further contribution from the beneficiary thereafter.

However, this argument only works where the scheme is small relative to the sponsoring employer. Table 1 shows a number of examples where the balance sheet of the pension scheme dwarfs the value of the sponsoring employer.

Table 1. Pension-scheme liabilities v. market capitalisation for three selected UK-listed companies. Source: LCP's "Accounting for pensions 2010" report.

CompanyPension
liabilities
Market
capitalisation
Liabilities /
Market cap.
British Airways£12.8 bn£1.6 bn791%
BT£33.2 bn£6.0 bn551%
Invensys£4.8 bn£1.3 bn364%

 

The sheer size of some pension schemes relative to the sponsoring employer is one thing, but a potentially more relevant comparison would involve the size of the funding deficit, i.e. the shortfall in assets relative to the scheme's liabilities. In some cases, pension schemes have a very large claim on the sponsoring company. This is illustrated in Table 2, which shows how the market values of some listed companies can be overshadowed by the scale of the funds requiring to be injected into the pension scheme.

Table 2. Pension-scheme deficit v. market capitalisation for three selected UK-listed companies. Source: LCP's "Accounting for pensions 2010" report.

CompanyDeficitMarket
capitalisation
Deficit /
Market cap.
BT£4.0 bn£6.0 bn66%
BAE Systems£5.6 bn£12.7 bn44%
British Airways£0.6 bn£1.6 bn37%

The finances of such companies are leveraged — a small relative change in the estimate of the pension-scheme liabilities could have a sizeable impact on the company's finances.  Although they are not regulated as life insurers, perhaps shareholders should be demanding insurer-like risk management of pension schemes?

 

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Stephen Richards
Stephen Richards is the Managing Director of Longevitas